The last week’s furore around the Internal Markets Bill has brought attention back to Brexit. Guy Foster, our Head of Research, has taken the opportunity to look at what it suggests about the state of negotiations and implications for the markets.
Since the end of January, the United Kingdom and the European Union have been busily negotiating to thrash out the finer detail – from trade tariffs to state aid – on how a post-Brexit relationship would work, before the 31 December 2020 deadline.
With the cut-off date for extending the transition period having passed in June, time is fast running out to agree on a deal and recent developments have meant the spectre of a no-deal Brexit is looming once more.
Last week, Prime Minister Boris Johnson told the EU that if a free-trade deal can’t be agreed by an EU summit set for 15 October, then both sides should “move on”. Two days later, the UK published its Internal Markets Bill – designed to protect trade arrangements between the countries that make up the UK – clearing a path for arrangements that would directly violate the Brexit withdrawal agreement signed with the EU last year.
The bill gives ministers powers to override some of the rules agreed in October 2019 for goods that cross in and out of Northern Ireland, alarming some with potential implications for the Good Friday Agreement. Legal experts were quick to denounce the move, saying that it was breaking international law, while many leading political figures in the UK have warned the UK’s international reputation is on the line. The EU said that the proposals put the negotiations at risk and Joe Biden has said that if he is elected president of the United States any UK-US trade deal would need to be contingent on respect for the Good Friday Agreement.
What has been the impact?
Such public arguments have been a prominent feature of the negotiations with the EU. Historically, these episodes have weighed on the value of the pound and caused the outperformance of the UK equity market, because a significant proportion of UK companies (particularly FTSE100-listed companies) derive their earnings from overseas. We witnessed this again last week as investors digested the latest developments causing the FTSE100 to rise by 4% and the pound to fall by 3.5%, against an average of the currencies of the UK’s trading partners.
There is no doubt that Brexit has had a destabilising effect on the UK and had an impact on the market ever since the UK voted to leave in June 2016. However, only a relatively small group of companies are at risk from Brexit. So, while parts of the retail sector, real estate, home construction and building, and banks each have varying degrees of exposure to the UK economy, the overall market tends to be exposed in large part to overseas currencies, most often the US dollar and euro.
As such, we would continue to expect that when it comes to Brexit-related stress, the worse things go, the greater the pressure becomes on the pound and the more positive the impact on the markets. Similarly, investors can take comfort that this tends to be supportive of UK bonds, as they perform inversely to the UK economy.
So, what next for investors?
The markets have yet to fully price in a no-deal Brexit – it has just been one more factor to consider alongside the prospects for Covid-19, fiscal stimulus and liquidity. If the prospect of no-deal continues to gather pace, the pressure on sterling will continue to grow.
However, as we have said continuously since the UK voted to leave the EU in May 2016, we don’t see Brexit as a huge investment risk. But it is a factor which we take into account when managing investments. Paradoxically, for most investments, the question becomes more about how we protect wealth when Brexit risks subside because, under those circumstances, we would expect to see the sterling rise and bonds sell off (all else being equal). As mentioned above there are however some stocks which will underperform as Brexit risks grow and some of these can offer good opportunities to purchase when market anxiety builds. Until that time the best thing to do is wait.
For what it’s worth, our view is that the latest standoff will prove to be an episode of brinkmanship. The intention of the government is to pressure the EU into making some concessions on the sticking points of any deal such as fishing and, most notably, state aid. In any negotiation, a party’s hand is strengthened if they appear to have an alternative to a successful deal and this seems to have been the hand both sides have tried to play throughout.
There has been a great deal of noise around the Internal Markets Bill, but history would suggest that, when push comes to shove, the Prime Minister and the UK government will withdraw the bill, allow it to be amended or at least avoid using it to override the UK’s treaty obligations. We’ve arguably already started to see this as the Prime Minister agreed to give the House of Commons a veto over whether the government can override the Withdrawal Agreement. European negotiators will now see this as a less credible threat.
Beyond Brexit, whether a deal is reached or not, the global economy will be influenced by many other factors over the coming months. The most important of these will be the economy’s recovery, progress in restraining the spread of COVID-19 and the willingness of policymakers to continue to provide support. November’s US presidential election will also be a significant event from an investment perspective. Particularly for political events, it is difficult to outthink the market on what is likely to transpire and so our activities tend to be more focused on how we respond when unexpected outcomes cause market volatility.
Whatever occurs, we will be carefully monitoring portfolios – and maintaining their diversity in order to afford some protection against any market events which do occur. We will also look to maximise any investment opportunities that arise this year and in a future post-Brexit world.
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